SAFE (Simple Agreement for Future Equity) notes are a simpler alternative to convertible notes. They were created in 2013 by Y Combinator, a Silicon Valley accelerator, and allowed startups to structure seed investments without interest rates or maturity dates. SAFEs are short five-page documents. The valuation caps are the only negotiable details. “In India it is popular as iSAFE note”. To comply with applicable Indian law:

• iSAFE note takes the legal form of compulsorily convertible preference shares (CCPS) which is convertible on occurrence of specified events.

• An iSAFE note is not a debt instrument, a founder friendly convertible security note, that is beneficial for both startups and investors
• They are governed by sections 42, 62, and 55 of the Companies Act, 2013 read with Companies (Share Capital and Debentures) Rules, 2014 and Companies (Prospectus and Allotment of Securities) Rules, 2014.
• Issuing iSAFE notes does away with the valuation exercise since the valuation is essentially postponed to a later date (when the priced round happens).

Types of iSAFEs: iSAFE agreement can be executed using any of these following options:

1. Fixed conversion at a fixed date where conversion is fixed at future date. (Mostly preferred)
2. Valuation Cap, no Discount where an investor negotiates terms relating to valuation cap (Minimum & Maximum value) but no discount allowed.
3. Discount, no Valuation Cap where investor can negotiate discount on valuation cap.
4. Valuation Cap and Discount where investor can negotiate both valuation cap and discount.
5. MFN (Most Favored Note), no Valuation Cap, no Discount: In case another SAFE note is issued, the company will have to tell the initial investor about it. In case the terms of the second SAFE are better for the investor as compared to the initial SAFE, then the investor can ask for the same terms. There will be no Valuation Cap and no Discount.

Conversion period of iSAFE notes:  iSAFE notes are automatically convertible either on occurrence on specified liquidity events viz. next pricing / valuation round, dissolution, merger / acquisition etc., Difference between iSAFE Notes and CCPS CCPS holders enjoy the following advantages over iSAFE Noteholders:

• CCPS holders usually get a right to exit in a Shareholders Agreement (SHA). iSAFE Notes can only be converted to equity on the occurrence of a liquidation event.
• CCPS holders may get a board seat. It is not common for iSAFE holders to have a board seat in the startup.
• When issuing CCPS, a third-party valuation is typically necessary. Issuing iSAFE Notes does not require a third-party valuation.

Benefits to Investors

• No dilution occurs in the cap table until the occurrence of the priced round or an early conversion.
• The duration to conclude the deal is reduced by at least a few weeks, attributed to the time saved in drafting a SHA and the accompanying multiple iterations.
• If the event of liquidation, the iSAFE Note holders get a preference over the founders and other equity shareholders. They get a higher right to receive whatever money is left in the startup, helping them recover at least a part of their investment.

Benefits to Startups

• Since iSAFE Notes are not classified as debt, no interest accrues on iSAFE Notes.
• An iSAFE note is a simple agreement. The startup will save significant money in engaging lawyers to draft detailed SHAs.

Legal Strucutre in India for iSAFE There is no specific law governing convertibles like iSAFE in India. Hence, to ensure their legal validity, they have been so designed as to take the form of Compulsorily Convertible Preference Shares (CCPS) and are governed by Sections 42, 55, and 62 of the Companies Act of 2013 read with the Companies (Share Capital and Debentures) and Companies (Prospectus and Allotment of Securities) Rules, 2014. Further, since it is only companies that can issue shares, partnership firms and LLPs cannot issue iSAFE. Could iSAFEs be designed as optionally convertible securities? Our analysis: Optionally convertible securities provide an option to either redeem or convert the security into equity at a specified date. Note that iSAFEs are agreements for ‘future equity’. Upon the occurrence of specified events, these notes are automatically converted into equity. This is to say that they do not provide any redemption option. Accordingly, it would be impracticable to issue them as optionally convertible securities. In case of iSAFEs, Instruments  are issued under non-debt mode and convertible mode and related features shall be associated and in case of Convertible note, it shall Another question that arises here is whether convertible notes are any different from iSAFEs. While the general characteristics of the two are very similar (being securities that are convertible into equity upon occurrence of specified events), however, convertible notes are in the nature of debt and give the holder the option to convert the debt into equity. This is in contrast to iSAFEs which do not give the holder an option of redemption and are required to be mandatorily converted into equity on the happening of the specified event. iSAFEs are having hybrid characteristics in terms of CCPS and Equity in future on achieving of certain events in an organization. However it is to be noted that Foreign Exchange Management (Non-Debt Instruments) Rules (‘FEMA NDI Rules’), 2019 is applicable and report to RBI under FEMA regulations. iSAFE’s cannot be issed under non-convertible instruments mode. iSAFE’S are issued with CCPS only due to avoid the interest component if its under CCD’S category. As this instrument is issued to early stage start ups, they will not be able to undertake interest component and lose their confidence with the investors. In terms of Fund raising event in the subsequent stages, Valuation can be done for the company and convert the issued CCPS to equity to enjoy the ownership in the company. Conclusion iSAFEs offer startups a swift and streamlined method to secure funding without the burdens of intricate agreements. Their flexibility and efficiency have become invaluable assets for new businesses trying to stay ahead. But, startup owners need to remember that using iSAFEs means they’ll gradually give up some ownership of their company. So, it’s important to think carefully before going ahead. In this scenario, engaging with experts, such as virtual CFOs, is widely regarded as best practice. These professionals can tailor iSAFE agreements to suit the specific needs of the startup, ensuring that critical elements like discount rates and valuation caps are meticulously calibrated. By following this standard practice and seeking guidance from seasoned professionals, startups today are confidently navigating the realm of iSAFEs, positioning themselves for sustained success amidst the competitive startup landscape.